Monday, July 28, 2014

If you are approached
with an unsolicited offer to buy your business, be careful. Often times it is a
bottom feeder looking to get a bargain and your company is one of dozens that
are similarly contacted. If you become intoxicated with the thoughts of future
riches, you could put your company in jeopardy. This article examines how you
should manage this process.

When
a company approaches you and broaches the subject of acquiring your company, it
is very difficult to suppress those feelings of riches beyond your wildest
dreams. Your thoughts start to move from the twelve hour work days, personnel
issues, keeping your clients happy, and drift toward the tropical island with
the grass hut, the perfect climate, the umbrella drinks, and the abundant
leisure time. Snap out of it! Put that Champaign away and get back to

reality.

We had been engaged by a client to sell her business recently
and while we were in the planning meeting, the assistant walked in with a
letter from a larger industry player expressing an interest in buying her
company. She was feeling pretty special until we uncovered that this same letter
was sent out to 50 other companies. Buyers are looking to buy at a discount if
possible. The way they do that is similar to the approach that many of those
get rich quick real estate programs recommend. Go out to 50 sellers and make a
low-ball offer and one of them may bite. These buyers are way better informed
about the value of a company than 90% of the business owners they approach.

The odds of a deal closing in this unsolicited approach are
pretty slim. In the real estate example, the home owner is not hurt by one of
these approaches, because they have a good idea of the value of their home. The
price offer comes in immediately and they recognize it as a low ball and send
the buyer packing. For the business owner, however, valuations are not that simple.
This is the start of the death spiral. I don't want to sound overly dramatic,
but this rarely has a happy ending. These supposed buyers will not give you a
price offer. They drain your time, resources, your focus on running your
business and, your company's performance. They want to buy your business as the
only bidder and get a big discount. They will kick your tires, kick your tires,
and kick your tires some more.

If they finally get to an offer after months of this resource
drain, it is woefully short of expectations, to the surprise or chagrin of the
owner. The owner became intoxicated with their vision of riches and took their
eye off the ball of running their business.

How should you handle this situation so you do not have this
outcome? We suggest that you do not let an outside force determine your selling
timeframe. However, we recognize that everything is for sale at the right
price. That is the right starting point. Get the buyer to sign a
confidentiality agreement. Provide income statement, balance sheet and your
yearly budget and forecast. Determine what is that number that you would accept
as your purchase price and present that to the buyer. You may put it like this,
" We really were not considering selling our company, but if you want us
to consider going through the due diligence process, we will need an offer of
$6.5 million. If you are not prepared to give us a LOI at that level, we are
not going to entertain further discussions."

A second approach would be to ask for that number and if they
were willing to agree, then you would agree to begin the due diligence process.
If they were not, then you were going to engage your merger and acquisition
advisor and they would be welcome to participate in the process with the other
buyers that were brought into the process.

A major mistake business owners make in this situation is to
focus their time and attention on selling the business as opposed to running
the business. This occurs in large publicly traded companies with deep
management teams as well as in private companies where management is largely in
the hands of a single individual. Many large companies that are in the throes
of being acquired are guilty of losing focus on the day-to-day operations. In
case after case these businesses suffer a significant competitive downturn. If
the acquisition does not materialize, their business has suffered significant
erosion in value.

For a privately held business the impact is even more acute.
There simply is not enough time for the owner to wear the many hats of
operating his business while embarking on a full-time job of selling his
business. Going through an extended process with a buyer who only wanted to buy
at a bargain can damage the small company. If you are not for sale, you must
control the process. Why would you go through the incredible resource drain
before you knew if the offer would be acceptable? Get a qualified letter of
intent on the front end or send this buyer packing.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Thursday, July 17, 2014

Business buyers do not
often reveal their hands about why they feel a business is an attractive
acquisition prospect for fear of driving up the price. They do, however, reveal
those features that detract from a business' value in order to try to drive
down the price during negotiations. This article discusses the value drivers
and value detractors in a business sale transaction.

As
it turns out, buyers are astute business valuation analysts. They look for
certain features when they assess the desirability of a business acquisition.
Private equity groups are particularly rigorous in this process. Without
exaggeration, we receive at least five contacts per week from private equity
groups describing their buying criteria. The most surprising statement
contained in a majority of these solicitations is the statement, "We are
pretty much industry agnostic."

They may add in a couple qualifiers like we avoid information
technology firms, start-ups and turn-arounds. Below is a typical description:Example Capital Group seeks to acquire
established businesses that have stable, positive cash flows and EBITDA between
$2mm and $7mm. We will consider investments that satisfy a majority of the
following characteristics:

Financial

Revenues between $10mm and $50 mm
EBITDA between $2mm and $7mm
Operating margins greater than 15%

Management

Owners or senior management willing to transition out of daily
operations
Experienced second tier management team willing to remain with the company

Business

Long term growth potential
Large and fragmented market
Recurring revenue business model
History of profitability and cash flow
Medium to low technology

I chuckle when I get these. You and 5,000 other private equity
firms are looking for the same thing. It is like saying I am looking for a
college quarterback that looks like Peyton Manning. Pretty good chance that he
will be successful in his transition to the pros. That is exactly what the
buyer is looking for - pretty good chance that this acquisition will be
successful once we buy it. Just give me a business that looks like the one
above and even I would look good running it.

On the other hand, more often than not we are representing
seller clients that do not look nearly this good. Getting buyer feedback on why
our client is not an attractive acquisition candidate is often a painful
process, but can be quite instructive. Unfortunately it is usually too late to
make the needed changes during the current M&A process. Many businesses are
great lifestyle businesses for the owners, but do not translate into an
attractive acquisition for the potential buyer because the business model is
not easily transferable and scalable.

In these businesses the value the owner can extract is greater
by just holding on and running it a few more years that he can realize in an
outright sale. What are these characteristics that reduce the salability of a
business or diminish its value in the eyes of a potential buyer? Below are our
top 5 value destroyers:

1. The business is too transactional in nature. What this means
is that too much of the company's revenues are dependent on new sales as
opposed to long term contracts. Contractually recurring revenue is much more
valuable than what might be called historically recurring revenue.

2. Too much of the business is concentrated within the owners.
Account relationships, intellectual property, supplier relationships and the
business identity are all at fish when the business changes hands and the
owners cash out and walk out the door.

3. Too much of the business is concentrated in too few
customers. Customer concentration poses a high risk for a new owner because the
loss of one or two accounts could turn the buyer's investment sour in a big
hurry. The buyer fears that all accounts are vulnerable with the change in
ownership.

4. Little competitive differentiation. Buyers are just not
attracted to businesses with no identifiable competitive advantage. A commodity
product or service is too difficult to defend and margins and profits will
continually be challenged by the market.

5. The market segment is too narrow, has too little potential,
or is shrinking. If your market place is so narrow that even if your company
had 100% market penetration and you sales were capped at $20 million, a larger
company would not get very excited about an acquisition because you could not
move their needle.

A business owner that is contemplating the sale of his business
could greatly benefit from this rigorous buyer feedback two of three years
prior to actually beginning the business sale process. A valuable exercise to
take business owners through is a simulated buyer review. During this process
we help identify those areas that could detract from the business selling price
or the amount of cash he receives at closing.

This process is certainly less painful than when we were
negotiating a letter of intent with a buyer from Dallas and he said to our
client, "Brother, your overhead expenses are 20% too high for this sales
level." Another buyer in another client negotiation said, "I can't
pay you a lot in cash at closing when your assets walk out the door every
night. It will have to be mostly future earn out payments."

As a business owner you can both identify and fix your company's
value detractors prior to your sale or you can let the new owner correct them
and keep all that value himself. Viewing your business as a buyer would well in
advance of your business sale and then correcting those weaknesses will result
in a higher sales price and a greater percentage of your transaction value in
cash at closing.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

For Business Owners Seeking Strategic Value in Their Company Sale

Have you ever marveled at the prices at which some companies sell while most others sell at predictable valuation metrics. Much of this value creation secret is the result of "STRATEGIC ASSETS". These are assets that do not appear on a company balance sheet, yet they are hugely valuable to strategic industry buyers. This checklist will help you identify, nurture, and develop key drivers of transaction value for your eventual business sale.